The cost of a simple will in 2004

By Steven T. O'Hara

Effective January 1, 2004, the U.S. government has increased the cost of a simple will. Here "cost" means a lost opportunity to save taxes and "simple will" means a will giving property outright to an individual who then has exposure to taxes.

The amount that may pass free of federal estate tax is known generally as the unified credit amount or, more recently, the applicable exclusion amount. For 2002 and 2003, this amount was $1,000,000. This $1,000,000 amount generally created the opportunity for two taxpayers, each with at least $1,000,000 in assets, to save anywhere from $435,000 to $500,000 in estate taxes.

Effective January 1, 2004, the applicable exclusion amount has been increased to $1,500,000 for estate-tax purposes only. This $1,500,000 amount generally creates the opportunity for two taxpayers, each with at least $1,500,000 in assets, to save roughly $700,000 in estate taxes.

Significantly, the applicable exclusion amount remains at $1,000,000 for gift-tax purposes. See the September-October 2001 issue of this column entitled "The Gift Tax Is Here To Stay."

For estate-tax purposes only, the applicable exclusion amount is scheduled to increase to $2,000,000 in 2006 and $3,500,000 in 2009. Each increase will result in a greater opportunity to save estate taxes, provided taxpayers structure their asset ownership, wills and trusts properly.

Consider a husband and wife domiciled in Alaska. Both are U.S. citizens. They have no assets outside Alaska and no material debt. Neither has ever made a taxable gift. In their estate planning, they believed they did not need to consider anything beyond simple wills because they had heard they each may pass, at death, as much as $1,500,000 in 2004 to their descendants without estate taxes. They figured with combined assets of no more than $3,000,000, or $1,500,000 each, their estates would never be subject to estate taxes. So they signed simple wills, giving all assets to the surviving spouse outright and to their descendants outright when there is no surviving spouse.

Husband has recently died. His surviving spouse now realizes that with assets of $3,000,000 (i.e., her assets plus the assets to which she is entitled under her husband's will), her estate would owe $705,000 in estate taxes if she died in 2004 (IRC Sec. 2001(c) and AS 43.31.011).

Thus the cost of husband's simple will could be $705,000 in estate taxes.

To avoid this tax exposure, the couple could have equalized their estates by separating assets so each owns $1,500,000 separately without any right of survivorship. Asset equalization could have been accomplished through an Alaska community property agreement, as long as "survivorship community property" is avoided (AS 34.77.030(c) and 34.77.110(e)). Then husband could have signed a will or living trust giving the applicable exclusion amount to a trust that would be available to his surviving spouse, but would not be included in her gross estate on her subsequent death.

In general, husband could have named his surviving spouse trustee of the trust without adverse tax consequences. See Adams and Abendroth, The Unexpected Consequences of Powers of Withdrawal, 129 Trusts & Estates 41 (August 1990), which provides an excellent discussion of distribution powers held by a trustee who is also a beneficiary or related to one.

The opportunity to eliminate or reduce taxes by giving property in trust, rather than outright, is not limited to the married couple. In other words, a simple will signed by a single individual can also be costly.

Consider a 90-year-old client with net assets of $1,500,000. He is not married and has never made a taxable gift. He has a 65-year-old daughter with her own net assets of $1,500,000. Both the client and his daughter are domiciled in Alaska, and their respective assets are all in Alaska. The client has a simple will, giving all to his daughter outright.

Suppose the client dies in 2004. His daughter would then learn that with assets of $3,000,000 (i.e., her assets plus the assets to which she is entitled under her father's will), her estate would owe $705,000 in estate taxes if she then died (IRC Sec. 2001(c) and AS 43.31.011).

Clients requesting simple wills need to consider that the simple will could ultimately cost their families hundreds of thousands of dollars.